Cost segregation studies remain one of the most powerful tax planning tools available to commercial property owners, enabling accelerated depreciation deductions that significantly improve cash flow and after-tax returns on real estate investments.
What Is Cost Segregation?
Cost segregation is an engineering-based tax strategy that identifies and reclassifies building components from their default 27.5-year (residential) or 39-year (commercial) depreciation schedules to shorter recovery periods of 5, 7, or 15 years. By accelerating depreciation deductions, property owners can significantly reduce current tax liability and improve cash flow.
The IRS has long recognized cost segregation as a legitimate tax planning strategy, and the Tax Cuts and Jobs Act of 2017 further enhanced its benefits by allowing 100% bonus depreciation for qualifying property placed in service through 2022, with phase-down provisions through 2026.
How Cost Segregation Works
A qualified engineering team conducts detailed analysis of building construction, identifying components that qualify for shorter depreciation lives under IRS guidelines. Common reclassifiable components include:
5-Year Property (Personal Property)
- Specialized electrical systems and dedicated circuits
- Decorative lighting and accent fixtures
- Carpeting and specialty flooring
- Kitchen equipment and built-in appliances
- Security and communication systems
7-Year Property
- Office furniture and fixtures
- Specialized storage systems
- Certain manufacturing equipment
15-Year Property (Land Improvements)
- Parking lots and sidewalks
- Landscaping and irrigation systems
- Site lighting and signage
- Fencing and retaining walls
Who Benefits from Cost Segregation?
Cost segregation studies can benefit virtually any commercial property owner, but the greatest impact is typically realized by:
- Owners of newly constructed or recently acquired commercial properties
- Property owners who have not previously conducted cost segregation studies
- Investors acquiring properties through 1031 exchanges
- Owners of properties with significant tenant improvements
- Real estate investment trusts (REITs) and institutional investors
- Properties undergoing major renovations or expansions
Quantifying the Benefits
The tax savings from cost segregation can be substantial. Typically, 20-40% of a commercial building's cost can be reclassified to shorter depreciation lives. For a $10 million commercial property, this could mean:
$2-4M
Reclassified to shorter lives
$600K-1.2M
First-year tax savings
2-4%
Improved cash-on-cash return
Bonus Depreciation Considerations
The bonus depreciation phase-down schedule makes timing critical for cost segregation studies. Under current law, bonus depreciation rates are declining annually, making it increasingly important to conduct studies promptly to maximize available deductions.
Selecting a Cost Segregation Provider
The quality of a cost segregation study directly impacts its defensibility under IRS audit. Key considerations when selecting a provider include:
- Engineering expertise with licensed professional engineers on staff
- Experience with the specific property type and construction methods
- Compliance with IRS Audit Techniques Guide for cost segregation
- Track record of studies withstanding IRS examination
- Comprehensive documentation supporting all reclassifications
Maximize Your Property's Tax Benefits
Our engineering and tax specialists have conducted cost segregation studies for portfolios totaling billions in property value. Contact us to learn how cost segregation can improve your investment returns.
Explore Real Estate Advisory ServicesCPCON Real Estate Advisory Team
Tax Strategy & Cost Segregation